With its stock down 14% over the past three months, it is easy to disregard Klingelnberg (VTX:KLIN). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Klingelnberg's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Klingelnberg

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Klingelnberg is:

12% = €17m ÷ €141m (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. So, this means that for every CHF1 of its shareholder's investments, the company generates a profit of CHF0.12.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Klingelnberg's Earnings Growth And 12% ROE

To start with, Klingelnberg's ROE looks acceptable. Be that as it may, the company's ROE is still quite lower than the industry average of 16%. Still, we can see that Klingelnberg has seen a remarkable net income growth of 25% over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this certainly also provides some context to the high earnings growth seen by the company.

We then compared Klingelnberg's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 14% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Klingelnberg's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Klingelnberg Using Its Retained Earnings Effectively?

Klingelnberg has a really low three-year median payout ratio of 17%, meaning that it has the remaining 83% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Moreover, Klingelnberg is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend.

Conclusion

In total, we are pretty happy with Klingelnberg's performance. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.